Keurig Dr Pepper Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 26, 2023

There are 9 speakers on the call.

Operator

Ladies and gentlemen, and thank you for standing by. Welcome to Keurig Doctor Pepper's Earnings Call for the Q3 of 2023. This conference call is being recorded and there will be a question and answer session at the end

Speaker 1

of the

Operator

call. I would now like to introduce Keurig, Doctor Pepper's Vice President of Relations and Strategic Initiatives, Jane Gelfand. Ms. Gelfand, please go ahead.

Speaker 2

Thank you, and hello, everyone. Earlier this morning, we issued 2 press releases. The first detailing our Q3 2023 results and the second announcing our sales and distribution partnership with Grupo Pizza Hut for Electrolyte. During today's call and consistent with previous quarters, we will be discussing our Q3 performance on an adjusted basis, which reflects constant currency growth rates and excludes items affecting comparability. Company believes that the adjusted basis, While not in accordance with GAAP, provides investors with meaningful comparisons and appropriate insight into our business and operating performance trends.

Speaker 2

Details of the excluded items are provided in the reconciliation tables included in our press release and our 10 Q,

Operator

which will

Speaker 2

be filed later today. Due to the inability to predict the amount and timing of certain impacts outside of the company's control, We do not reconcile our guidance. We'll also speak about the concept of underlying performance, which removes the impact of non operational items in the current and prior years. These items include gains and asset sale leaseback transactions, reimbursement of litigation expenses related to the successful resolution of our BodyArmor lawsuit, a business interruption insurance recovery and a change in accounting policy for stock compensation. Finally, our discussion this morning may include forward looking statements, which are subject to the Safe Harbor provisions

Speaker 1

of the Private Securities

Speaker 2

Litigation Reform Act of 1995. These Reform Act of 1995. These statements are subject to a number of risks and uncertainties that can cause actual results to differ materially and the company undertakes no obligation to update these statements based upon subsequent events. A detailed discussion of these risks and uncertainties is contained in the company's filings with the SEC. Here with us today to discuss our results are KDP Chairman and CEO, Bob Gamgort and our Chief Financial Officer, Sudhanshu Priyadarshi.

Speaker 2

I'll now turn it over to Bob.

Speaker 1

Thanks, Jane, and good morning, everyone. We are pleased with our Q3 results. ADP's diversified beverage portfolio and strong execution continue to support consistent delivery of our company goals and commitments, even as the operating environment around us remains dynamic. In Q3, healthy organic sales growth and significant gross margin progress fueled reinvestment and bottom line growth, reinforcing visibility to our full year outlook, which remains unchanged. 3rd quarter constant currency net sales grew 4.1%.

Speaker 1

As expected, Net price realization moderated from the first half, but remained the primary top line growth driver, while volumemix strengthened sequentially. Our performance reflected continued share gains in U. S. Refreshment Beverages, Gradual recovery in U. S.

Speaker 1

Coffee segment results and strong momentum in our international business. Gross profit margin expanded significantly, up 100 basis points year over year and the largest improvement in 4 years, reflecting an improved balance between ongoing inflation, Pricing and Productivity. Our gross profit growth enabled us to continue reinvesting in the business, including increased marketing for the 3rd consecutive quarter, while simultaneously driving bottom line growth, which was slightly above the expectations we shared with you back in July. As we move through Q4 and plan for next year, We expect our revenue growth drivers to continue to normalize as pricing moderates relative to recent history and volume mix To be clear, pricing is expected to remain a key part of the top line equation, especially considering that inflation is likely to persist, albeit at more moderate levels than over the last couple of years. Simultaneously, our focus will be on supporting volume mix by balancing margin flexibility between reinvestment and future top line growth and earnings flow through.

Speaker 1

Let me take a step back and frame how we assess consumer health, our portfolio and our strategy in the macro environment. The consumer remains healthy The demand resilient and category elasticity is manageable. Even so, consumers are closely calibrating where and how they shop. For instance, growth in club and other value oriented channels has accelerated. While the convenience of e commerce and pickup and delivery services continues to resonate well after any pandemic related uplift would have normalized.

Speaker 1

Consumers remain responsive to high quality innovation and activation, but price and package architecture is another increasingly important dimension, including smaller pack sizes that hit key price points and multi packs that offer value and convenience. On the margin, we also see some migration of lower to middle income households towards at home meal and beverage occasions, which should benefit our more essential categories like CSDs and coffee. Our business is well positioned against this backdrop, thanks to a compelling all weather growth model. The ability to seamlessly meet the consumer across all beverage needs states and to service those occasions across all channels is at the heart of why we formed this modern beverage company. Since then, we've made even more progress as we significantly grew the portfolio reach and strengthen our internal capabilities.

Speaker 1

Looking forward, our distribution prowess across retail is broad based with very strong in market execution. Yet we also enjoy a scaled online business, particularly on the coffee side. Our robust 2024 innovation pipeline has been well received by the trade and spans product, format and packaging news that captures a combination of value and premium price points as well as low and no calorie and indulgent beverages. We also continue to price nimbly across the entirety of our portfolio, including by leveraging our strong mix management capabilities. Short, the consumer is resilient but choiceful and KDP is positioned to drive attractive top line growth through a combination of volume, Mix and price levers.

Speaker 1

Our successful growth model rests on our exclusive focus on North American Beverages and a winning strategy. Begins with KDP's powerful twin distribution assets, our multi channel cold beverage distribution system, including DSD and an installed base of nearly 40,000,000 active households using the Keurig system. This is an unparalleled combination in the industry, which enhanced by strong R and D and commercial backbone, enables us to grow our categories and gain share across our base business and further build out our portfolio through high value M and A and partnerships Yes. With counterparts who increasingly seek us out. When we fill in category white spaces Such as through our announcement today of the partnership with Electrolyte fuels a virtuous cycle of growth, Investment and growing returns on that investment.

Speaker 1

As the new brand scale and our portfolio expands, our capabilities get stronger. Drop sizes get bigger, our merchandising gets more impactful, we service each store and household more frequently and our commercial and consumer relationships tighten. This enables further investment and growth that begins the cycle anew. We have proven this model over multiple years. In U.

Speaker 1

S. Refreshment beverages, we have consistently outperformed our categories, growing dollar share in at least 75% of our business in all but two quarters since the beginning of 2019. We also entered multiple strategic white spaces within the past 12 months, such as ready to drink coffee, energy and after today's announcement sports hydration. All were achieved in a very capital efficient manner. The growth path ahead is increasingly evident with both owned and partner brands.

Speaker 1

The latter where our relationships are strategic and long term, growth and mix are positive and our economics are attractive. Coffee, the single serve segment has continued to steadily gain share of at home coffee, cementing Keurig's leadership position with this important category. At the same time, we are expanding our total coffee strategy to encompass ice, ready to drink and other forms of coffee within and beyond the K Cup format. And in Canada and Mexico, We have leveraged similar strategies across our refreshment beverages and coffee business as well as deeply experienced Local teams to build a combined business approaching $2,000,000,000 in revenue with a mid-20s operating margin. As a result, our international segment has become a scaled contributor to the overall portfolio with significant growth runway ahead.

Speaker 1

I'll now briefly discuss how this strategy played out in Q3, with Sudanshu to follow with greater detail and guidance. In U. S. Refreshment beverages, 82% of our business outpaced category growth in the quarter. CSD business is healthy.

Speaker 1

Doctor Pepper building on the momentum of strawberries and cream earlier in the year with a successful 6th season of the iconic Fansville marketing campaign. Other brands such as Canada Dry and Squirt also saw strong gains. And Polar's momentum continued in sparkling water, where it now commands the number 2 volume share position. Core and Evian remain strong drivers in premium waters with Core in particular Seeing great traction from our partnership with U. S.

Speaker 1

Gymnastics. That said, we have work to do elsewhere in the STIL portfolio, including with Bi, which is undergoing a significant restage and reformulation next year. Importantly, our partnership with NutriVault on C4 is proceeding very well. In Q3, C4's market share and earned display accelerated, while velocities remain strong across those regions where KDP has taken control of the brand's route to market. Even as the C4 rollout continues in its 1st year, We have significant room for future growth in energy where KDP's market share is only 3% and C4 has tremendous potential.

Speaker 1

With the electro lead announcement today, we are extending our portfolio into the large and important sport hydration category, Another quickly growing mix accretive white space for KDP. Electrolyte is a brand that has established Strong regional foothold, thanks to its unique product attributes, scientific heritage and extremely loyal customer base. The brand is the market leader in sports hydration in Mexico and that popularity extends to the U. S. Where Electroly enjoys broad multicultural appeal, but over indexes with Hispanic consumers.

Speaker 1

Doughnut has good scale today in the U. S. And already generates more than $400,000,000 in retail sales, Representing more than a tenfold increase over the past 5 years, Electrolyte has significant upside potential. We are excited to partner with Grupo Pisa, Electrolyte's parent company to meaningfully expand the brand's distribution breadth and depth in the U. S.

Speaker 1

And across all channels, while also leveraging KDP's commercial expertise to further enhance the brand's position at retail. With C4, La Colomme and Electrolyffe having entered our portfolio over the last 12 months, We have meaningfully increased the growth potential for each of these brands, while extending a positive halo on the rest of our business. For example, our total volume in chain convenience stores will increase by approximately 50% after incorporating these brands, providing scale and efficiency benefits across the entirety of our portfolio. This is a virtuous cycle that I described just a few minutes ago and which will continue to fuel KDP's success. Turning now to U.

Speaker 1

S. Coffee, where our back half is focused on driving segment margin improvement in the context of gradually improving at home coffee category volumes. With visible progress on both fronts, let's address each in turn. I'll start with the segment margin improvement. We have a greater ability to control in the short term than we do with category trends.

Speaker 1

Q3, we began to deliver against our objective with a strong inflection in segment margins and operating income, which meaningfully improved both sequentially and year over year. Importantly, we expect the margin improvements to continue. We previously said the delayed pricing would flow through our partner brands and it has. We have now strengthened the pricing protocols across these long term partnerships and do not expect any significant lag between inflation and pricing to recur in the future. Plus, Modity cost headwinds are now moderating and productivity is building across the segment, enhancing our visibility to continuing to grow the bottom line even with ongoing reinvestment.

Speaker 1

Moving to category performance, at home coffee category volume growth accelerated relative to Q2, but the pace of recovery is admittedly gradual. From Q2 to Q3, volume trends across the broader category strengthened by about 100 basis points in measured channels, So volumes are still modestly lower year over year. Single serve continues to gain share of at home coffee With our proprietary data, which is more comprehensive, spanning both measured and untracked channels, indicating that Q3 Keurig Compatible pod consumption volume was approximately flat versus year ago, proving from down approximately 3% in Q2. These green shoots are encouraging, and we will continue to nurture them as the single serve market share leader. During the quarter, we saw our competitors begin to lean more aggressively into price promotions in the single serve category, resulting in some share shifts across the various brands in the ecosystem.

Speaker 1

As a reminder, Because we manufacture nearly 80% of all Keurig compatible pods in the U. S, we tend to participate even as share changes occur between our branded and private label partner brands and our owned and licensed brands. Nevertheless, we must responsibly manage Our owned and licensed brands price gaps within the category and intend to stay nimble to the changing operating conditions around us. Importantly, as we choose to surgically respond to the recent price activity, we expect segment margins to accelerate in Q4. We also do not expect the competitive pricing activity to meaningfully accelerate at home coffee category volumes, which we know are far more responsive to high quality activities that influence consumer choice and lean into emerging trends.

Speaker 1

As the single serve leader, KDP will continue to drive category growth as we always have through innovation, Renovation and white space expansion that build penetration with new households and increase usage among our existing consumers. With 90,000,000 U. S. Households drinking coffee at home, of which fewer than 40,000,000 are actively using Keurig brewers, There is a significant multi year opportunity ahead. 2024, we will continue to pursue that growth through New consumables like cold brew, expanded ice varieties and refreshers.

Speaker 1

New brands like La Colome, which by the way begins to ship Ready to drink and K Cup format starting in Q4. Significantly new innovation in brewers, all supported by strong marketing and brand activation activity, including exciting new collaborations across our owned and licensed brands. Moving on to our international performance in Q3, which remained impressive with revenue growth once again in double digits and continued segment margin expansion. Both our coffee and refreshment beverages businesses performed well. Canada, the ready to drink alcohol and no alcohol segment is growing and we are contributing to that growth.

Speaker 1

AT and T gained significant share as velocity and distribution built and a blast from the past vodka based tahiti treat RTD generated consumer demand. In Mexico, our powerhouse Pena CL and Squirt brands both grew at a double digit rate. Leveraging our strong go to market and DSD capabilities behind which we continue to invest. In Mexico, like in the U. S, we have significant growth potential ahead across both our core portfolio and through partnerships as we leverage these unique distribution assets.

Speaker 1

KDP's strong balance sheet and cash generation profile are powerful enablers of our broader growth strategy. With today's Electrolyad announcement yet another example of how we can grow our portfolio and market reach in a highly capital efficient manner. As a result, our finance our financial policy approach can be flexible and dynamic. This year, we are deploying some of our cash to strategically reduce our supplier financing program. Simultaneously, we announced a 7.5% increase in our annual dividend, furthering our track record of regularly growing dividend income for our shareholders.

Speaker 1

With over $3,000,000,000 remaining on our share buyback authorization and having already repurchased 24,000,000 shares of KDP Stock over the last 2 years, we have substantial flexibility to opportunistically lean in when we see compelling value in the business we know best. Wrapping up, our 3rd quarter results represented another period of consistent Delivery against our commitments. Our top line growth was strong and resilient and we reinvested in our brands and differentiated capabilities. We also achieved important proof points in our margin recovery journey this quarter as visible in our consolidated gross margin progress and in U. S.

Speaker 1

Coffee segment results. Our Q3 results provide enhanced visibility to our unchanged 2023 outlook For constant currency net sales growth of 5% to 6% and adjusted EPS growth of 6% to 7%.

Speaker 3

We expect to

Speaker 1

close out 2023 having significantly improved our composition of earnings profile, lending further support to our aspiration to be on algorithm in 2024. I'll now turn it over to Sudhakshu.

Speaker 3

Thanks, Bob, and good morning, everyone. Our consolidated 3rd quarter results were solid. Top line growth was resilient. We supported future momentum by reinvesting in the business and we delivered modest EPS upside Relative to the expectations we shared with you last quarter, revenue advanced 5.1% to $3,800,000,000 with healthy constant currency sales growth of 4.1%. Pricing remained the primary growth driver, contributing 5.5 points.

Speaker 3

As expected, this was a moderation from the 2nd quarter as prior year pricing actions were lapped. Volumemix strengthened sequentially, posting a modest 1.4% decline year over year. Gross profit margin inflected positively in the quarter and expanded a strong 100 basis points year over year as pricing and efficiency gains began to offset input cost inflation. Total SG and A deleveraged 130 basis points year over year, reflecting our focus to reinvest in our brands and capabilities while combating sustained inflation. SG and A saw another quarter of double digit increases in marketing spending, while transportation, warehousing and other corporate costs such as labor remains headwinds.

Speaker 3

Adjusted operating income grew 3.1%, which combined with below the line leverage resulted in mid single digit EPS growth to $0.48 slightly ahead of the guidance we shared last quarter. We achieved this result without the benefit of any non operational gains in the quarter as we continue to make progress on reinforcing our earnings base looking out to next year. Moving to the segments. Quest Refreshment Beverages grew net sales 5.9%, led by 7.1 percentage points of pricing. The price contribution moderated quarter over quarter as anticipated as We began to anniversary some of the last year's pricing activity.

Speaker 3

Volumemix declined 1.2%, reflecting outperformance versus our categories across the vast majority of our portfolio and the growth contribution from Seaport Inertia. As Bob said, we expect price to remain a continued driver of the top line growth algorithm in quarter 4 and into next year, even as growth rebalances across volume, mix and pricing contributions. Consumer is resilient, category elasticities are manageable and inflation Moderating remains a headwind. Segment operating income grew 6.1% in the quarter and segment margins were approximately flat year over year. This performance reflected The favorable impact of pricing and productivity, net of inflation, offset by increased investment in marketing.

Speaker 3

In U. S. Coffee, net sales decreased 3.2%, improving versus the 2nd quarter trough As expected, pricing sequentially strengthened and contributed 3.1 percentage point of growth. Some of this reflected pricing that lagged realized inflation across our partner portfolio and is now flowing through after a delay. In future cycles, we expect the pricing pass through necessary to be more seamless.

Speaker 3

Volumemix declined 6.3% year over year in quarter 3. Growers grew 8% as we moved past destocking in the first half and shifting for the important holiday period. For the back half as a whole, we expect brewer shipments to track point of sale strength, which remains softer in today's macro environment and are still declining in the mid to high single digits compared to last year. Importantly, Keurig brewers continue to gain share within the coffee maker category and We still expect to finish the year having grown penetration to approximately 40,000,000 households in the Qurate ecosystem as compared to approximately $38,000,000 at the end of 2022. All shipments declined 8% Similar to last quarter, however, by our measure, category consumption volume in single server flat year over year across all channels, sequential improvement relative to quarter 2.

Speaker 3

As we previewed what happened last quarter, Shipments lagged category consumption in the period due primarily to 2 factors. 1st, The competition against a year ago channel inventory build and second, the volume impact from our decision to exit certain low margin private label contracts. We anticipate a smaller combined impact from these factors in quarter 4 and expect core shipments to sequentially strengthen relative to quarter 3. Office segment operating income grew 5.7% and operating margins expanded strongly. At nearly 33%, segment operating margins increased 280 basis points versus the prior year and also compared very favorably relative to 30.4% in the first half.

Speaker 3

This significant inflection was driven by pricing, productivity and moderating inflation, and we expect it to sustain. As Bob mentioned, the path of the expected revenue recovery is slightly altered relative to our original plan due to some prudent price reinvestment in a competitive environment. Nevertheless, margin trends are expected to accelerate further in quarter 4. Fundamental progress is expected to drive Continued solid operating income growth year over year even as we lap a difficult comparison given nonoperational benefits partially contributed to U. S.

Speaker 3

Coffee operating income last year. International segment sales increased 20.8% in the 3rd quarter against a double digit growth comparison in the year ago period. Constant currency sales growth was very strong at 12.9% with volume mix increasing 9% and pricing up 3.9%. Our top line momentum are broad based across Mexico and Canada. Segment operating income grew very strongly at 39.4% on a reported basis and 31.7% in constant currency terms, Thanks to operating leverage and efficiency gains netting favorably against inflation.

Speaker 3

As anticipated, our free cash flow conversion strengthened sequentially In the Q3 to $459,000,000 reflecting the combination of profit growth and moderating working capital uses and consistent with our expectation for free cash flow conversion to strengthen in the second half. Our capital allocation approach remains unchanged. Our priorities include organic and inorganic investments to support our growth, further strengthening our balance sheet Consistent, we have a long term net leverage ratio target of 2 to 2.5 times and returning cash to shareholders through our dividend and opportunistic share buybacks. We dynamically adjust between these priorities on an ongoing basis. In quarter 3, we closed on the highly strategic La Colome partnerships first introduced in July, which included a $300,000,000 equity investment.

Speaker 3

Today, we announced another important partnership with Grupo Pizza to sell, distribute and merchandise Electrolyte in the U. S. This is a meaningful step forward into sports hydration for KDP and establishes another mix accretive growth platform even as it comes with minimal capital commitments. As Bob pointed out, with entries into energy, RTD coffee And Sports Hydration over the past 12 months, we have penetrated 3 large and important white spaces for a relatively modest capital outlay of less than 1,300,000,000 Also have the ability and desire to continue to return cash to our shareholders. In September, we announced A 7.5 percent dividend increase marking our 3rd consecutive year of growing our dividend and representing a cumulative 43% increase over that time.

Speaker 3

Our share repurchases will remain opportunistic and we have demonstrated a willingness step in when our share price becomes dislocated from the long term value we expect to create. Approximately $3,200,000,000 remaining on our share repurchase authorization, we will continue to assess the market for such opportunities. Moving now to guidance. We are reaffirming Our consolidated outlook for 2023 and continue to target constant currency net sales growth of 5% to 6% and adjusted EPS growth of 6% to 7%. Our EPS outlook assumes minimal benefits from non operational items in 2023 implying double digit EPS growth on an underlying basis.

Speaker 3

Our guidance for below the line items is consistent with last quarter. For the year, we continue to expect interest expense in a $470,000,000 to $475,000,000 range, Effective tax rate of 22 percent and approximately $1,410,000,000 diluted weighted average shares outstanding. We expect a strong end to the year in quarter 4 with similar top line dynamics to quarter 3 and even a stronger gross margin expansion. At the same time, we will be lapping approximately $67,000,000 of non operational gains in last year's 4th quarter, primarily concentrated in the U. S.

Speaker 3

Coffee segment, which creates a challenging comparison. Letting these factors together, we expect Q4 adjusted EPS of approximately $0.54 or 8% year over year growth. On an underlying basis, this represents strong double digit EPS growth. With that, I will now turn the call back to Bal for closing comments.

Speaker 1

Thanks, Sudhaku. I'd like to close by saying how excited we all are that Tim Coefer is joining KDP as Chief Operating Officer on November 6. From there, we are looking forward to a smooth CEO transition between Tim and me in Q2 next year and continuity as I serve as KDP's Executive Chairman thereafter. Upon joining KDP, Tim's immediate focus will be immersing himself in the business. We will also partner with Sudhaku, the full executive leadership team and me to drive our annual operating planning process For 2024.

Speaker 1

A lot of robust work is underway and we expect to provide you with a detailed outlook when we report our Q4 results. For now, let me just say that our entire organization is focused on delivering a strong finish to 2023. We expect that Tim will join Sudhakar and me in this forum in February, and I know you will enjoy meeting him after that. I'll now turn the call back to the operator for questions.

Operator

We will now begin the question and answer session. We ask that you ask one question and one follow-up. At this time, we will pause momentarily to assemble our roster. Our first question will come from Andrea Teixeira with JPMorgan. You may now go ahead.

Speaker 4

Hey, good morning. This is Drew Levine on for Andrea. Thank you for taking our question. So I first wanted to ask on U. S.

Speaker 4

Coffee, if you could talk more specifically to the trends during the quarter, both in tracked and on tracked channels. If the recovery is sort of playing out sequentially as you expected and what we could think about the exit rate for September October being? And then secondarily, I think the expectation was for pod volumes to perhaps see moderating declines in the quarter. They were pretty flat. So anything changed incrementally during the quarter from a pod shipment perspective?

Speaker 4

Thank you.

Speaker 1

Sure, Drew. Thanks for the question. On our last call, we talked about 2 drivers of improved coffee And so that goes beyond single serve to all forms of coffee consumed at home. Obviously, as you saw in the results, we've received The inflection that we expected in the margin side, and that's largely under our control and a big driver of our performance. The category is experiencing sequential improvement, but admittedly it is gradual.

Speaker 1

When we take a look at consumption of single serve And we use our proprietary data, which looks at tracked and untracked channels. And remember, The tracked channels represent roughly 60% of total consumption. We're seeing that the volumes are flat, which is an improvement sequentially, but a bit slower than we expected. And so That's really the core of any shipment shortfall versus expectations, is really driven by the category. I would remind you within that, that single serve and KDP continues to grow share within that category.

Speaker 1

Well, the theme that we've talked about before about controlling the controllables margin, share performance, all are really quite good. The challenge is really this total at home coffee category, which is moving in the right direction, albeit at a slower pace. My last comment on that is what we're experiencing on At Home Cough in the U. S. Is not unique to the U.

Speaker 1

S. It's a trend that we're seeing in most developed markets as well.

Operator

Our next question will come from Dara Mohsenian with Morgan Stanley. You may now go ahead.

Speaker 5

Thanks. So just to follow-up, do you expect the category will continue to recover going forward From here, can we get back to growth going forward? And maybe can you detail what's driven the acceleration in untracked channels and how Sustainable that is going forward. And then just second, if you could take a bit of a look out to 2024, you mentioned On algo for the total company, does that apply to the coffee business in terms of a more normalized organic sales growth and profit growth pace as look out to 2024? Thanks.

Speaker 1

Sure. I think that when you take a look at The shipment trend or the trajectory of the coffee category, I think it speaks for itself. We talked a lot about mobility as a big driver and we certainly weren't the only ones that were looking at that. So mobility is no longer a factor. It's gone back to more of a normalized environment.

Speaker 1

And so I think that the trajectory that we're seeing right now on improved coffee consumption will continue. The drivers of that, I There are multiple contributors to the slower but steady improvement in the category, including Really a change in work routines where you're looking at more hybrid work. The afternoon occasion, for example, changes on that. On the margins, we could see some impact from pricing and inflation and also some of the trends in cold coffee, Which also indexes to out of home, but there's nothing structural going on right now. And you can imagine we spent a lot of time digging into the fundamental consumer drivers of coffee.

Speaker 1

The tailwinds are incredibly strong. The movement towards improving growth looks to be right in front of us here. But we're being honest in saying that the total at home coffee category has been more gradual than we originally expected. Although we don't like I said, we don't see anything as structural. With regard to the untracked channels, why is that stronger?

Speaker 1

It's really driven by club and e commerce. E commerce, which Was growing prior to the pandemic, accelerated significantly during the pandemic and it really has shown no signs of pulling back from that. And we've talked before about the importance of e commerce in our total business, but you can imagine when you look at individual segments That single serve coffee is really an ideal segment for e commerce. It's lightweight, high value, long shelf life, Not fragile a ship. So you can really have a quite a good business on e commerce.

Speaker 1

In addition to that, remember we've been Increasing our own subscription business and services to the consumer. And as we put more smart brewers out there and allows For smart consumption based reordering, I think that e commerce will continue to grow. And I think club It was overall consumer shift towards that channel. It represents a good value. I also think that some of the changing Away from home coffee trends, meaning office coffee trends have also benefited the club channel as well as people in small and midsize offices are picking up There are supplies there as well as in e commerce.

Speaker 1

And then with regard to 2024, I mean, we've given you our macro outlook. We're not going to break it down by individual segments. The one thing I would say that I believe is important is this gradual or more gradual rebound in Coffee is something that we've been able to factor in our thought process as we think about our total company Algorithm. And obviously, it's something that we've digested and built into our expectations.

Operator

Our next question will come from Brian Spillane with Bank of America.

Speaker 6

You may now go ahead.

Speaker 7

Thanks, operator. Good morning, everyone. Maybe Bob, maybe to just pick up on that last point and maybe a little bit higher level just thinking about the consumer. As we're going through this earnings season, it's there just seems like economizing behavior in a lot of different forms has Kind of evolve more as we've moved through the back half of this year and Hershey talked a little bit about it this morning as well. And So can you give perspective on 2 things?

Speaker 7

1, just how you're thinking or how KDP is thinking about The consumer next year stronger, weaker, and how maybe you're adjusting your plans across all businesses for that? Then the second just because it's been so topical just kind of how you how KDP is digesting all of the Sort of information about GLP-one and is that something you'll be getting to factor into your longer term plans? Thank you.

Speaker 1

Yes. Thank you, Brian. Thanks for those questions. We plan our business on a range of outcomes. We said that before.

Speaker 1

We've been very Watchful of the consumer and concerned about trade down behaviors as a result of financial pressures. As we said, the consumer today remains incredibly resilient, but we're thoughtful about how that might Shift into the future. We look across our entire portfolio, we have the ability to shift across formats, mix, Channels price pack architecture on both the refreshment beverage side and the cold beverage side, I mean, and the coffee side, To be able to react to any of those changes. But as of right now, we haven't really seen that. There is a potential cascade that happens Where you could talk about within traditional retail where consumer looks to lower priced items And shops in more value oriented channels.

Speaker 1

There's another piece as well, which is a cascade from away from home to in home. And some of the surveys that I've looked at recently is, if you are pinched, these are consumer surveys. If you're pinched, what do you give up first? And what the consumer gives us first is dining out of home and travel. And so I think that what happens is that in home where we benefit from them.

Speaker 1

And if you could take a look at the broad portfolio across all formats, but also Specifically within coffee, we've been working really hard to provide the consumer with options to produce specialty coffee, cold coffee, coffee of any form that they get out of home, in home. And so I actually think that's a benefit for the category going forward. So The conclusion is nothing as we sit here today, very possible in the future and certainly in our range of planning, but lots of flexibility for us To deal with it and potentially some upside on certain segments, including coffee. With regard to GLP-one, we've had the opportunity to look at Every trend possible from a consumer perspective for opportunities and risk. We've spent a lot of time digging into the most robust Data that's available and I would caution everybody that the data that is actually available is really limited at this point.

Speaker 1

What we would want to see As an industry, before you get up with any conclusions is you'd want to see known GLP-1 users and be able to match their behavioral data over time. Self reported data, survey data, trying to figure out who might be a GLP-one consumer is really dangerous. The data that we're able to get into, which is quite limited on actual GLP users And their known consumption for us is neutral, may even be different That by meaning more positive, but let me just say neutral right now. And here are the facts. And I think it actually makes sense with just plain good sense, Which is, there's no evidence that people drink less in terms of beverages.

Speaker 1

So unless you believe the consumption of tap water is going up, There's no indication of that. And somebody in the beverage industry is picking up those sales. Are mix shift possible? Absolutely. But we haven't seen anything Significant data that we have in front of us within the world of beverage.

Speaker 1

And I would remind you that we have a very, very broad portfolio. And in fact, more than 60% Of our products, as in our corporate responsibility report are classified as positive nutrition. So it's very similar to the conversation on recession. Consumers don't drink less. If they change their mix in terms of which formats and types of beverages they consume, we have one of those occasions.

Speaker 1

And also we have the ability to innovate should we choose to. We've had some questions on coffee, specifically all the data that we can see right now, there's No impact on coffee consumption as a result of that. So when we step back, we are surprised By the reaction, and quite honestly, we're surprised that the conversation is about food and beverage. I don't we don't participate in the food industry, but I can tell you in the beverage industry, I really think that there's little to be concerned about here. Having said that, we're going to continue to study.

Speaker 1

We'll get more robust data. We'll be able to What I said before, which is known GLP-one users and their actual consumption patterns over time. And I think the picture will become much clearer, but that's our conclusion today.

Operator

Our next question will come from Robert Ottenstein with Evercore. You may now go ahead.

Speaker 8

Great. Thank you very much. Two questions. First, congratulations on the deal with Electrolit. When I was at NACS A month or so ago, it was all the rage, a lot of talk about it.

Speaker 8

Can you just you mentioned that it was Creative to your mix. Can you talk about what that means? Because I would have thought this is just a distributor margin that you're getting. So Maybe talk to us about the impact on your business. And then the second question is And this is kind of outdated.

Speaker 8

If you go back before Keurig and you talk to the old management team about the smaller pack sizes, Doctor Pepper was lagging and there was a little bit of pushback saying that going into these different variety of pack Sizes and can sizes would add unneeded complexity and I know a hell of a lot has changed since then. I'm just wondering Where you are in terms of your manufacturing and canning capabilities today in terms of meeting that greater variety of pack sizes? Thank you.

Speaker 1

Yes. So, Robert, I'm glad that you saw Electroly At NACS and the excitement about NACS, this is a business that we've been tracking for some time and we've been really impressed with There's strong growth. The fact that their consumer target is multicultural, and it's a perfect example, as we've discussed With C4, with La Colom, with Polar, where we can take a brand that is very strong and has a clear consumer base and opportunity And help them grow through expanded distribution, improved merchandising and access to our Well, RGM capabilities, category management capabilities and more. And so this one I think is another one of these win win structures. When we think about Electroly coming into our business and its implications on 2024, clearly, it's a contributor to revenue growth.

Speaker 1

Similar to what we talked about with C4, in its 1st year of incorporation, we don't think about it as much of a driver of profit growth. But when you get into its 2nd year, it will be able to contribute profitability and we'll provide framing around that at that time. And that's because we make significant investment in the 1st year to get the brand on board. And also as we discussed earlier, this gives us a wonderful opportunity to put more investment in our route to market system to be able to improve coverage with the fact that we now have larger job sizes an increased frequency. And as we said a number of times, that benefits all brands within our system.

Speaker 1

The fact that we Put in the that we put in the prepared remarks about the 50% growth in large outlet C stores for us is a very significant Consideration here in terms of our ability to cover our convenience stores for our entire portfolio. So This is yet another great example of how we're able to build our capabilities. Your point about smaller pack sizes, yes, the world has changed quite a bit. We have substantial distribution and we have good manufacturing flexibility on small pack sizes. We see them as an incremental driver of growth.

Speaker 1

They happen To also be margin accretive, they're very much in line with consumer trends where if somebody wants to treat themselves in a portion of our portfolio is in the treat need state that we give them an opportunity to do so in a smaller pack size. And that's been the case in other CPG Industries. And as we think about our manufacturing base going forward, Flexibility in formats and pack sizes is a critical capability that we continue to invest in To give us the optionality of price pack architecture moving forward.

Operator

Our next question will come from Bonnie Herzog with Goldman Sachs. You may now go ahead.

Speaker 6

Thank you. Good morning, everyone. Bob, I was hoping you could give us some more color on the exiting of certain private label contracts In terms of maybe how big these customers are and if there's an expectation for more to come. And then you called out a tough comparison On your pod volumes in the quarter, given the trade inventory builds in the year ago period. So just trying to understand How big of an impact you think that was?

Speaker 6

And could you just confirm, I thought you said this, that you're already starting to See pod volumes improve in Q4. Thanks.

Speaker 1

Yes. So on the first one, on the Actually, there are some private label partners that really began in Q2. I mean, the best way for you to size it is you can take a look at Track data for the most part and just see KDP manufactured share and it's going to show you where unlicensed versus licensed private label is. And, I don't think that that's a it's not a it's definitely not a driver of profitability and it's a minor contributor to revenue, but it's the right thing to do over the long term. We offer significant value to our partners.

Speaker 1

And we're also the driver and the player who invest in brewer innovation, brewer launches, which is the catalyst for the entire industry. And from time to time in these negotiations, we find partners on the other side who don't want to pay for the value added. There's a point in which we don't drop price because we know that we add that value. And I would also point out that in almost every circumstance, Both partners have come back to us over the long term because they miss what they get from KDP. So you'll see it in the tracked channels and I don't think it's a big deal.

Speaker 1

2nd part of the question was about the you asked a bit about inventory and that's really a question about the gap between shipments and consumption. The best way to characterize that is that if we tell you that the category rebound Is going in the right direction, but not at the pace that any of us expected. When I say any of us, anybody who operates in the coffee industry, developed markets globally, Then there's always going to be a disconnect between shipments and consumption and there may be some shipments ahead of consumption based on those expectations. That's happened. That's normalizing.

Speaker 1

Expect that gap to narrow further in Q4. So to me that's a lagging indicator. A contributor to the shipment piece, which is worthy for a conversation in this quarter. But over the long term, the pieces to really watch are How is the at home coffee category performing? Because that really drives everything.

Speaker 1

How is our share Total single serve and total KDP share of at home coffee that continues to expand. And then the last part of it is our margin against that Volume, which also is very high and improving. The combination of those 3 really does create value. But again, it's created some short term disruption as we get out of this Got it. Still the after effects of the rebound from the pandemic piece.

Operator

Our final question will come from Chris Carey with Wells Fargo Securities. You may now go ahead.

Speaker 1

Hey, everyone. Good morning, Chris. I know you're not going to specify What drove the margin improvement in the quarter specifically? But can you maybe help frame The relative contribution of pricing, of productivity, of easing Commodity inflation or maybe it was even a benefit. And also you've been quite adamant that the mix impact Of your own portfolio underperforming is not as great as what is sometimes debated.

Speaker 1

And so I wonder how that Impacted the quarter as well. And you're clearly looking for an acceleration in margins in Q4. And I think really what I'm trying to do is You'll get some confidence that, well, okay, pod volumes could be volatile. Within your portfolio, they could be volatile. But As you go into next year, here's why we're going to continue to have visibility on margins even if shipments or otherwise Are a bit different than maybe what we would expect 1 quarter or 2 quarters out, right?

Speaker 1

So we're really trying to help frame the Q3 margins and Yes, it's kind of get some help on the go forward. Thanks so much. Yes. Let me talk about the Margin inflection that we've seen in the quarter and we talked about prior to that. And then I'll ask Sudanshu to take a look at where we are on from a segment OI perspective and a forward outlook on that.

Speaker 1

We had a number of conversations in the past as you'll recall about the gap between pricing to partners and private label Versus the inflation that was that we were experiencing that had never been contemplated In the years in which we had the prior years in which we had signed those agreements. And remember that's very different than pricing that you see at retail, to be clear, because I know when I say pricing, people immediately go to retail pricing. What I'm talking about is the contractual pricing that we have with partners in private label, Who then in turn set their own retail pricing as a result of that. And so, he said that there was a lag, but it would flow through. It's flowing through.

Speaker 1

We have great visibility to it going forward to answer your question because it's contractual. And I think the other point To make and it's an emphasis of the prepared remarks is that we've now adjusted all of those agreements going forward And we don't expect a substantial lag to between pricing and inflation to occur in the future. So Lessons learned from the past, bit of pain that we had to incur over the past couple of years, but that's all catching up right now and you're seeing that flowing through. In addition to that partner and private label pricing flowing through, we're also seeing some moderation in inflation And we're experiencing an increase in productivity. As we said a couple of times, when we were in a supply chain disruption mode and we were capacity standpoint, And we have the ability now to focus on productivity and dial that up.

Speaker 1

So it's a combination of partner private label pricing, productivity and moderating inflation That is contributing to the margin inflection you're seeing now and also our confidence and visibility into the future. Sinatra, why don't you take a minute and talk more about that last piece?

Speaker 3

Thanks, Bob. Chris, if you think through think about Q4 and beyond, in Q4, we are Expecting a sequential improvement in port shipment as category is gradually recovering. We're also planning to have margin expansion in quarter 4 higher than quarter 3. We talked about that before. And we'll also see a solid operating income growth in quarter 4, even a stronger underlying.

Speaker 3

As you all know, We had a lot of non operating benefit in coffee. So you will have a stronger underlying growth because we're planning minimal non operating thing. As you think through 2024, our plan is to continue to gradually rebuild margin in the coffee category. Started With quarter 3, you saw we went from 30% roughly in the first half to 33%. Q4 will expand further, And you will see this gradual buildup or rebuild up of our margin in 2024.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Jane Galphon for any closing remarks.

Speaker 2

Thanks, Anthony, and thank you, everyone. We appreciate your time and attention this morning. And as always, the Investor Relations team is available to answer any follow-up questions you may have. Have a great day.

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Earnings Conference Call
Keurig Dr Pepper Q3 2023
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